The municipal bond coupon and redemption payment reinvestment that occurs in June, July, and August is expected to be subdued this year, which could impede the market’s near-term performance, according to a Lehman Brothers report released last week.
The heavy reinvestment that occurs over the summer months — a phenomenon known as rollover season — is expected to be down 21% from 2005, and 16% lower than the average volume over the past five years, according to the report.
“We expect there to be potential indigestion in the market over the near term as new-issue volume has picked up and there are substantial secondary market bid-lists competing with increased supply for what is a diminished peak reinvestment season for buyers,” Peter DeGroot, a municipal bond strategist at Lehman and author of the report, said in a telephone interview.
Redemption payments are expected to total $41.8 billion in June, $37.2 billion in July, and $29.6 billion in August, the Lehman report stated, citing figures provided by Thomson Financial. As compared to $50.76 billion, $41.92 billion, and $28.74 billion, respectively, in the same months in 2005.
“In our market, there tends to be a high correlation between funds that are coming due — your coupon and redemption payments — and the amount of investable capital in the hands of buyers,” DeGroot said on Wednesday.
Typically, the summer reinvestment season helps the market absorb an increase in supply that begins to occur in June. June often receives the highest amount of issuance of any month, according to the Lehman report.
While supply through the end of May had been trailing that of 2005 significantly, it has since begun to improve, and supply this June is expected to be similar to its trailing five-year average of $35.3 billion in issuance, according to Lehman.
This year, in addition to the increase in issuance that typically occurs in June, the secondary market is also awash in offerings. On Monday, Employers Reinsurance Corp. began circulating the first of what is expected to be $7.5 billion in municipal bonds it is looking to liquidate after its parent company, General Electric Co., sold the business to Swiss Re, according to market sources.
“The demand quotient of the market is further compromised by the relative richness in our asset class in comparison to Treasury- and Libor-based hedges, as well as BMA, which incentivizes arbitrage and hedge fund investors to sell securities in the cash market,” DeGroot said in the interview. While the analyst believes it could be a difficult time for the market in the near term, he said municipal bonds could further underperform taxable bonds if interest rates fall.
